The largest US banks have a $100bn liquidity shortfall to meet new rules, which force them to maintain a cash cushion in case of a future credit crunch, according to the Federal Reserve.
US regulators on Wednesday are expected to finalise the liquidity coverage ratio requiring banks to hold a certain amount of assets that could be quickly turned into cash, a key component of global reforms aimed at helping banks better withstand another financial crisis.
Banks subject to the rule would have to hold a total of about $2.5tn in high quality liquid assets over a 30-day stress period if the proposal was in effect now, Fed officials said, more than they have. Assets considered to be of the highest quality include Fed reserves and Treasury securities.
The liquidity rule applies only to the largest US banks. But the Fed anticipates proposing a plan that would extend the liquidity measures to the US holding companies of the largest foreign banks, which have to be established by July 2016 under new Fed rules.
“As the financial crisis demonstrated, most of our largest and most systemically important financial institutions did not hold a sufficient amount of high quality liquid assets to independently withstand the stressed market environment,” Fed chairwoman Janet Yellen said.
Complying with the liquidity rule will be phased in, with banks having to fully meet the requirements by January 1, 2017, a more stringent deadline than the Basel III rules that give banks until January 1 2019.
The plan largely mirrors the initial proposal issued in October. The biggest difference from the original plan is the final rule allows the biggest banks to phase in the daily reporting requirements and calculate their liquidity coverage ratio on a monthly basis during that transition period.
Regulators also broadened the categories of certain debt and equity securities that can be counted as high quality liquid assets. Under the final rule, any investment grade corporate debt security issued by a non-financial sector company that has a proved liquidity record can be included in a certain category of liquid assets.
Local governments were one of the groups that expressed serious concern about the liquidity rule because it did not count municipal bonds as high quality liquid assets that banks would want to hold. US cities warned they would face budget crunches to pay for schools, roads and sewage systems if the liquidity rule is approved.
Although the final rule still excludes muni bonds, the Fed staff recommended establishing a new proposal that would allow the most liquid muni bonds to be included as high quality assets.
In another change, the final rule does not apply to certain nonbanks that have been designated as systemic risks by the Financial Stability Oversight Council, such as AIG and GE Capital. A different liquidity rule is expected to be issued for those companies.
In a separate move, officials also proposed new rules on margin requirements for swaps that are not cleared by a central counterparty that differ from the initial 2011 plan to take into account liquidity costs for market participants. It also largely reflects recommendations made by the global Basel Committee of regulators in September 2013.
Regulators said Wednesday they hoped the plan provides incentives for such transactions to be cleared.
As part of global reforms in the derivatives markets, many kinds of swaps are required to be cleared, but certain tailored swaps were not included in that mandate, leaving regulators worried about loopholes.
The new proposal sets a minimum initial margin requirement for a covered swap entity involved with a counterparty that is a financial end user or swap entity, which is much more stringent than standards for cleared swaps.
Five things to know about the US liquidity coverage ratio ru le
(1) Banks have to hold high quality liquid assets equal to projected stressed cash outflows over a 30-day period.
(2) Requirement applies to the largest US banks. Regulators expect to issue a similar rule for the biggest foreign banks with US operations in the future.
(3) Banks have to be fully compliant by January 1, 2017, two years before the Basel III deadline.
(4) Municipal bonds are still excluded from high quality liquid assets but regulators are working on a proposal to include the most liquid muni bonds at a future date.
(5) The rule doesn’t apply to nonbanks designated as systemic risks by US regulators. Officials will come up with a separate liquidity proposal for them.